By Senator Dick Lugar
The dangers of high oil prices may be only beginning. Global oil markets are hanging on by the slimmest margin, leaving every American motorist -- and our economic recovery -- vulnerable to hostile governments, terrorist strikes on infrastructure, extreme weather or other shocks.
Oil prices are again above $100 a barrel and likely to increase. Higher prices are a genuine hardship for many Hoosier families and small businesses struggling to make ends meet. Every 10 percent increase in oil prices is expected to knock 0.25 percent off economic growth -- meaning it most likely will be all the harder for job creation to catch up with employment needs if prices continue to rise.
This worrying trend is taking place against a seemingly favorable backdrop. Despite the Obama administration's slow-walking production on federal land, U.S. crude oil production is climbing, so supply is up. Meanwhile, U.S. demand is down, partly because of the recession and partly because of increasing fuel economy in our vehicles, which began under President George W. Bush.
So why are we in this squeeze? Several factors are at play, including loose monetary policy that inflates oil prices. Continued unrest and poor governance in oil-rich countries also adds to the risk premium now attached to every barrel.
The problem, fundamentally, is that oil prices are set in a global market, and that market has changed. Booming demand by China, India and other emerging economies quickly absorbs new supplies. Old oil fields are running low while new ones are expensive and harder to find.
This means two things: First, there are no easy solutions to high gasoline prices, despite the simplistic proposals out there. Second, the tight global petroleum market puts us at risk of an unpredictable oil price surge that could be ruinous to our economy.
Price stability depends on a cushion of excess oil production capacity that could be brought online within 30 days or so if needed. A good rule of thumb is 5 percent of the market -- now about 4.5 million barrels per day -- is a sufficient cushion. Drop much below that, and the market cannot easily cope with planned or unplanned outages.
Historically, almost all that cushion has been in Saudi Arabia, giving rise to the deplorable situation that the price Americans pay for gasoline directly depends on Riyadh.
The cushion today is just 1.4 million barrels per day of spare capacity in a global market of approximately 89 million barrels, according to analyst Bob McNally, of the Rapidan Group. Some estimates are even lower. That thin margin already inflates prices, but it also puts global oil markets on the edge of massive upheaval.
These dual challenges of high prices and volatility require a robust and pragmatic response, without rhetoric and posturing. We must, in the near term, develop contingency plans like emergency reserve usage and fuel switching to meet any shortages and blunt price spikes. The current danger underscores the vital need to halt costly regulation and formally bring the major oil-consuming nations, China and India, into international emergency coordination.
The Democratic Senate leadership recently called on President Barack Obama to ask Saudi Arabia to boost production. Going hat in hand to Riyadh is not a real solution -- and it's all the more ironic since those same leaders are blocking transport of secure and affordable oil supplies from North Dakota, Montana and Canada through the Keystone XL pipeline.
Keystone XL approval would be an important signal to markets of coming supply and our Hoeven-Lugar-Vitter Keystone XL legislation would get the job done. Incredibly, the president personally lobbied against our bill last week -- despite analysis from his own Energy Department that this pipeline would help lower gas prices. Fifty-six senators voted in favor of the bill.
The global oil market is likely to remain precarious for the foreseeable future. So our energy policy needs clear direction in reducing the threats to our economy, and our national security, from potential oil shocks.
That means we need to ramp up safe, reliable production of domestic oil, including through enhanced oil recovery. We also must promote more private investment in alternative fuels produced from biomass and coal by removing burdensome regulations.
We also need a clear and flexible policy encouraging automobile innovation to boost fuel efficiency.
Pursuing these three main goals, my Practical Energy Plan would reduce the need for foreign oil from unreliable nations by more than 6.3 million barrels per day -- more than two-thirds of what we now import. Commitment to a real "all the above" energy solution cannot wait for this crisis to pass -- or the next to come.